UNITED STATES TAX COURT

JMP

T.C: Memo. 2012-67

UNITED STATES TAX COURT

AMERISOUTH XXXII, LTD., AMERISOUTH TEXAS III, LLC, TAX

MATTERS PARTNER, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21686-07. 042

Filed March 12, 2012.

Matthew I. Root and Jennifer S. McGinty, for respondent.

MEMORANDUM OPINION

HOLMES, Judae: AmeriSouth XXXII, Ltd. bought an apartment complex

in 2003 for $10.25 million. The Commissioner argues that with minor exceptions

SERVEDMar122012

-2the apartment complex is one asset that AmeriSouth must depreciate over 27.5

years. AmeriSouth argues that, whatever the apartment complex may look like to

an untrained bserver, to a tax adept it is not a single asset but a collection of more

than 1,000 components depreciable over much shorter periods. It is usually the

case that a shorter depreciation period benefits taxpayers. It would certainly

benefit AmeriSouth by generating hundreds of thousands of dollars' worth of

accelerated depreciation deductions. We are tempted to say this is why

AmeriSouth throws in everything but the kitchen sink to support its argument-except it actually throws in a few hundred kitchen sinks, urging us to classify them

as "special plumbing," depreciable over a much shorter period than apartment

buildings.

Background

.

This st ry begins with a limited liability company called AmeriSouth Texas

III, LLC and i s managing member and 100-percent owner, Ruel Hamilton, a realestate veteran. AmeriSouth Texas is the general partner in "something like" 50

AmeriSouth p rtnerships dubbed AmeriSouth I through--the record's a bit

uncertain--AmeriSouth XLII, plus a few with slightly different names. Each

AmeriSouth partnership owns an apartment complex, and over the years

AmeriSouth Texas has owned approximately 10,000 apartment units, mostly in

-3Texas. AmeriSouth Management, L.P., which Hamilton also manages, maintains

at least some of these apartment complexes.

This case involves only one of the AmeriSouth Texas.partnerships,

AmeriSouth XXXII, Ltd. AmeriSouth Texas established AmeriSòuth XXXII in

2003 to buy the Garden House Apartments (Garden House) in Mesquite, Texas i

Built in 1970, Garden House sprawls across more than 16 acres of land and

includes more than 40 buildings, most of which are two-story apartment buildings

averaging nine apartments each. The complex also has some conÃnon buildings-three pool cabanas, a storehouse for mechanical equipment, and a'leasing office

building. Most units are one to three bedrooms, although there are a few fourbedroom units.

Of its 366 units, approximately 70 are fully-furnished "guest apartments."

And even unfurnished units contain dishwashers and garbage disposals. Some

units have laundry rooms and hookups for washing machines and dryers with their

own plumbing·and electricaliconnections. There are also laund

areas with their

own plumbing and electrical connectioris in some of the apartmeñts for renters

who either bring their own machines or»rent them from AmeriSouth. And for

' AmeriSouth XXXII bought Garden House for $10.25 million. When

AmeriSouth bought Garden House, rent ranged from $410 to $1,317 per month

and occupancy stood at 82 percent.

those renters who don't rent or bring their own, an outside company--Coinmach-maintains washers and dryers in seven common laundry rooms. These laundry

rooms have f oor drains, plumbing, and gas lines.

At leas some of Garden House's units sport painted base molding (a strip of

wood at the base of the wall where it meets the floor), crown molding (same idea

but at the ceiling), and chair rail (somewhere between the floor and ceiling, and in

1

this case usually only in the dining rooms). Besides chair rail; the dining rooms

also feature a lbuilt-in, framed mirror, and some have a ceiling light with a paddle

fan. Some kitchens and living rooms have shelving set into the wall and about 80

apartments have hardwood floors instead of carpeting:

Garden!House of course has electric and gas lines, water pipes, and sanitary

sewers drawing from the main city lines underground, though some electrical lines

arè overhead. There are public access, utility, and sanitary-sewer easements,

running from the public street across AmeriSouth's property to its buildings.

Electricity flows into the complex from overhead lines down to an underground

transformer on}AmeriSouth's property. The transformer, which AmeriSouth

doesn't own, rëduces the voltage in the wires to a residential level. From there,

secondary electric lines carry the current to outdoor light posts and to main

electrical panels on each building. The wires split again after'hitting the main

panel and spider throughout the building behind the walls to panels in each

apartment. From there they run throughout each apartment, where they end behind

outlets and junction boxes for light fixtures. At least one report sliows that many

of Garden House's electric panels aren't properly labeled.

Renters plug into the electricity;via many outlets'scattered throughout the

buildings. Each apartment's kitchen has a duplex (two-prong) outlet four feet

above the ground behind the refrigerator and a three-prong, 220-volt outlet for the

sole purpose of powering the stove. There are also duplex·outlets above the

countertops, presumably for small kitchen appliances. In apartment units with

laundry areas, there is a duplex outlet where the clothes washer niay be installed

and a three-prong, 220-volt outlet for the clothes dryer. The com on laundry

rooms have typical electric outlets in areas designed for clothes y ashers, while the

office building has duplex outlets in places convenient for office and exercise

equipment. And there are specialized outlets for cable lines, data lines, and

042

telephones in apartments and the office building.

Each apartment and the office building has a stainless steel kitchen sink, and

there is a plastic utility sink in the office building as well. Garbage disposals are

set into one of the drains of the kitchen sink in each apartment uñit and the office

building so that the waste piping connected to the garbage dispo als carries away

-6 the water an waste coming from the kitchen sinks. The garbage disposals are

electric and l$1ug into electric outlets located near them. The dishwashers also

plug into electric outlets, but they have their own smaller water lines that branch

off from the main water line.

As sooû as AmeriSouth bought Garden House, it began a $2 million

renovation ofithe apartments that included replacing cabinets and countertops,

dishwashers, garbage disposals, vent hoods, and kitchen sinks.

As it prépared to file its 2003 information return, AmeriSouth needed to

decide how to report its income and expenses. One major expense it faced was

depreciation. Apartment buildings generally get depreciated over 27.5 years, and

AmeriSouth originally listed Garden House as "27.5-year property" in its records.

Before it filed ts 2003 information return, however, AmeriSouth scouted out a

more advantageous position. It hired MS Consultants to do a cost-segregation

study. MS visited Garden House and mentally deconstructed it into over 1,000

parts. MS advised AmeriSouth that items such as sinks, outlets, paint, and the

electric wiring bonnected to garbage disposals could be depreciated, not as part of

the buildings they were attached to, but by themselves. Because a sink, for

example, has a shorter expected life span than an apartment building, depreciating

these components separately would have sped up Garden House's depreciation

-7considerably, leading to lower taxes for AmeriSouth. MS calculated that about

$3.4 million of AmeriSouth's property could be depreciated over 540

or 15 years

instead of 27.5. This increased AmeriSouth's depreciation deduction by

approximately $397,000 in 2003, $640,000 in 2004, and.$375,00Q in 2005. MS

boasted that its plan for Garden House would defer taxes of almost $730,000 for

2003 through 2007.

The cost-segregation study separated the components at issue mto the

following 12 categories:2

042

site preparation and earthwork;

042

. water-distribution system;

042

sanitary-sewer system;

042

gas line;

042

site electric;

042

special HVAC;3

042

special plumbing;

042

, special electric;

2 The parties adopt these categories for ease of discussion, and so will we,

without attaching any legal significance to the titles.

.

3 HVAC means heating, ventilating, and air conditioning.

finish carpentry;

millwork;

interior windows and mirrors; and

special painting.

AmeriSouth took MS's advice, reporting depreciation on its returns as

follows:

Year

Depreciation expense

2003

$632,674

2004

1,578,212

2005

818,143

AmeriSouth claimed on its returns that the water-distribution and sanitarysewer systems; the gas lines, and the site electric were eligible for 15-year

depreciation; it claimed property in the other categories was eligible for 5-year

depreciation. The Commissioner disagreed, reasoning that some of the parts

AmeriSouth wants to depreciate quickly can be depreciated only as pieces of a

whole building that it must depreciate more slowly over 27.5 years and that some

of the parts that AmeriSouth wants to depreciate aren't depreciable at all. He

issued Final Partnership Administrative Adjustments4 for 2003, 2004, and 2005,

denying deductions of $314;996, $508,977, and $255,778, respectively. The

Commissioner raised one more argument for the first time'at trial- that

AmeriSouth was also trying to depreciate sóme assets it doesn't even own.

AmeriSouth Texas, as AmeriSouth's TMP, filed a petition to challenge the

Commissioner's adjustments, and we tried the case in Buffalo, New York. The

default appellate venue, however, is likely the Fifth Circuit becau 541e

AmeriSouth's

principal place of business was in Dallas, Texas, when the petitio was filed. See

sec. 7482(b)(1)(E).5

.

040Partnerships

themselves don't actually pay income tax--instead, each

partner reports a pro-rata portion of the partnership's income on his individual tax

return. To try to reach consistent results among partners and decrease the cost of

auditing partnership returns, Congress enacted the Tax Equity andl Fiscal

Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, sec. 402(a), 96 Stat. at

648. Under TEFRA, the Commissioner audits a partnership at the partnership

level. If the Commissioner makes any adjustments to partnership items after

concluding the partnership-level audit, he issues a Final Partnership

Administrative Adjustment to alert the partners. Each TEFRA partnership is

supposed to designate one of its partners as TMP--tax matters pa ner--to handle

TEFRA issues and litigation for the partnership. AmeriSouth Texas is

AmeriSouth's TMP.

5 Unless otherwise indicated, all section references are to the Internal

Revenue Code in effect for the years at issue, and Rule references are to the Tax

Court Rules of Practice and Procedure.

- 10 Addin another twist, AmeriSouth sold Garden House about the time the

case was trie , and stopped responding to communications from the Court, the

Commissioner, and even its own counsel. We suspended briefing in an attempt to

figure out what was going on and ended up ordering AmeriSouth to show cause

why its attorneys should not be allowed to withdraw from its case. Without any

response to tlze Court, we granted the attorneys' motion to withdraw and so

AmeriSouth has been left representing itself. The Court then ordered AmeriSouth

to file a posttrial brief, which it never did.

Because the Court ordered a posttrial brief and AmeriSouth didn't file one,

we could disn3iss this case entirely. See Rules 123, 151(a); Stringer v.

Commissioner, 84 T.C. 693, 704-08 (1985), aff'd without published opinion, 789

F.2d 917 (4th Cir. 1986). Despite AmeriSouth's lack of response and mysterious

disappearance!however, we will not do so. We will, though, deem any factual .

matters not otherwise contested to be conceded. _S_ee Diesel Country Truck Stop,

Inc. v. Commissioner, T.C. Memo. 2000-317.

4

Discussion

.

.

The details of depreciation spur many to more interesting pastures, but the

basic concept i 541

easy to understand. A general goal of taxation is to match the

income and th expenses associated with producing that income. See INDOPCO,

-

-11 -

Inc. v. Commissioner, 503 U.S. 79, 84 (1992). In this way taxes nïore closely

reflect economic profit. Items that are bought and used in the same year are easily

identified as deductible costs related to that year. And smaller exlsenses, even if

for items that last longer than a year, are often deductible rather than depreciable

just because it is too cumbersome to keep track of each pencil or aperclip.

Yet a taxpayer who buys longer lasting, more expensive items, like

manufacturing equipment, may have a large cash outlay in one year that will help

produce income for many years to come. Without some sort of allocation, the

economic wear and tear of the equipment will not offset that futuse income-instead, the taxpayer would have an inflated loss iii the year he b ught the

equipment.

And that's what depreciation recognizes--taxpayers take reasonable

deductions against income for the exhaustion and wear and tear of property used

in a trade or business or held for the production of income. See sec. 167(a). In

this way, taxpayers recover the cost of their investments as they dre used. And

because depreciation is an accounting creation that reflects gradual wear and tear,

and not the initial cash expense, it follows that assets that cost möney but don't

suffer from wear and tear-like land--are not depreciable. See sec. 1.167(a)-2,

Income TaX Regs.

-12So mu h for theory. Applying depreciation in the real world can be more

difficult. This is in part because it uses a very specific but not-so-intuitive

vocabulary. For example, to calculate a depreciation deduction, a taxpayer must

first determine the "basis" of an asset (usually its cost, at least initially), see secs.

1011, 1012, 1016, as well as the asset's "class life"--a range of years reflecting the

anticipated useful life of that type of property to a particular industry or other

group, see sec. 168. Then the method of depreciation determines the amount he

can deduct ea h year.

For proþerty placed into service after 1986 (and all property in this case),

the Code gene ally requires the use of the Modified Accelerated Cost Recovery

System.(MACRS).6 See Tax Reform Act of 1986, Pub. L. No. 99-514, secs. 201,

203, 100 Stat. at 2121, 2143. The first step in using MACRS is classifying the

assets to deteribine the proper recovery period. This is what AmeriSouth and the

Commissioner are fighting about here. MACRS provides lists of the appropriate

classifications for some specific assets. See sec. 168(e). (Race horses older than

two years whe they are placed into service, for instance, are specifically listed as

6 Thougli Garden House was built in 1970, AmeriSouth first placed it in

service by buyihg the complex in 2003, so MACRS applies to all property in

question. See Broz v. Commissioner, 137 T.C. 25, 37 (2011) ("An asset is placed

in service wheri'it is acquired and put into use" by the taxpayer).

- 13 "3-year property." Sec. 168(e)(3)(A)(i). If an asset doesn't fit into one of the

listed categories, then the taxpayer must classify the asset by class life. See sec.

168(e)(1). For example, an otherwise unclassified asset expected to last more than

four years but less than ten would be "5-year property." Id.

Once an asset is classified, MACRS then tells us the applicable depreciation

method and recovery period.7 See sec. 168(b) and (c). Residential rental property

commands its own category: MACRS specifically requires use of the straight-line

method and a recovery period of 27.5 years. See sec. 168(b)(3)(B), (c). This

means that AmeriSouth can deduct a portion of Garden House's basis over the

course of 27.5 years.8

But what is Garden House for purposes of MACRS? Ame iSouth argues

that Garden House is not only apartment buildings--which both p rties agree are

residential rental property--but apartment buildings >vith over a tl ousand pieces of

tangible personal property that just happen to be attached. This classification,

resting on MS's cost-segregation study, posits that these pieces aie 5-year and 157 MACRS also provides the applicable "convention" whicl helps a taxpayer

determine when it may start depreciating an asset that was pla'ced into service part

way through a tax year. See sec. 168(a), (d): Don't worry about this wrinkle--it's

a term of the depreciation equation that's not in dispute.

8 The depreciation clock for residential rental property begins in the middle

of the month it is placed in service. See sec. 168(d)(2).

- 14 year property--for which the Code mandates recovery periods of 5 and 15 years,

respectively, and directs the use of declining-balance depreciation methods. See

sec. 168(b) and (c). Declining-balance methods allow taxpayers to take higher

depreciation deductions in the earlier years of an asset's life, which would further

accelerate A ieriSouth's recovery of its costs.°

9 In the case of 5-year property, a taxpayer would start by using the doubledeclining-balance (DDB) method until switching to the straight-line (SL) method

would become more advantageous. See sec. 168(b)(1). And then there's the

alternative minimum tax, that parallel tax system that applies nearly flat rates but

strips out favörable tax deductions and exemptions, which, if applicable, would

require a taxpäyer to make depreciation adjustments based on the 150-percent-

declining-bal nce (150DB) method. See sec. 56(a)(1).

Consider a simplified example (that ignores some conventions for

simplicity's sake): If the 5-year property costs $10,000, the SL method evenly

allocates the c st over the five years--$2,000 per year, or 20 percent of the total

cost. The 20 percent is the initial SL rate, but when looking at the depreciable

balance--the cost of the property minus previously deducted depreciation--that

rate changes. Thus in the second year, the $2,000 of depreciation is 25 percent of

an $8,000 balapce ($10,000 cost minus year-one depreciation). A similar

calculation yields a 33 percent SL rate in year three; 50 percent in year four; and

100 percent, i. 040.,

the remaining balance, in the final year.

The taxl$ayer-friendly 150DB and DDB methods take the first-year SL rate

of 20 percent a d multiply it by a factor of 1.5 and 2 respectively. They then

multiply the resulting 30 percent and 40 percent rates by the depreciable balance

each year until it becomes more favorable to apply the SL rate in a given year.

Thus, in this example, under the 150DB method, the SL rate would apply

beginning in y ar 3.

- 15 The Commissioner, on the other hand, argues that all of the property in

question is residential rental property. He says the components in q estion are

integral to the apartments' operation and.maintenance and should thus be

classified as structural components, depreciable over the life of the buildings.

But the Commissioner first tries to ride down and tie up a fevk dogey

arguments--claiming that AmeriSouth is trying to depreciate some ässets it doesn't

even own and some other assets that it does own but that just aren't depreciable.

We deal with these first.

I.

AmeriSouth's Depreciable Interests

The Commissioner argues that AmeriSouth doesn't own or b ar the

replacement risk for the gas, water, and sewer lines, and therefore it isn't entitled

to depreciate their cost. He also argues that AmeriSouth's claimed site preparation

and earthwork, if it even occurred, relates to the land, and so is not epreciable.

A.

Depreciation of Utility Lines

The Commissioner now asserts that AmeriSouth doesn't own portions of the

water-distribution system, sanitary-sewer system, gas line, and undbrground site

electric (which we'll just call the utility lines) and therefore can't dhpreciate them.

The Commissioner makes the same argument regarding the overhead electric

- 16 lines. Because the Commissioner has raised these questions for the first time at

trial, he bear the burden of proof. See Rule 142(a)(1).

For a t xpayer to depreciate an item, he must bear the loss when that

property weais out: See Helvering v. F. & R. Lazarus & Co., 308 U.S. 252, 254

(1939). So even if AmeriSouth owns certain property, if someone else repairs or

replaces it, AineriSouth can't properly claim a deduction because it isn't financially

hurt by the wear and tear. See Mayerson v. Commissioner, 47 T.C. 340, 350

(1966) ("[D]epreciation is not predicated upon ownership of property but rather

upon an investment in property").

The parties provide an abundance of information about what "typically"

occurs and who "generally" owns or repairs utility lines but are more reticent with

information about who owns or repairs the utility lines Garden House actually uses.

AmeriSouth claims that developers typically pay for and install utility lines such as

those in this case, and so it should be entitled to depreciate them to recover its

predecessor's nvestment. The Commissioner points to the fact that the lines are

located underground within a sanitary sewer easement held by the City of Mesquite

and also introduces evidence of a general utility easement which grants all public

utilities full right of ingress and egress "for the purpose of constructing,

reconstructing, inspecting, patrolling, maintaining and adding to or removing all or

-17part of its respective systems" on AmeriSouth's property. All of this, the

Commissioner claims, proves the underground utility lines do not belong to

AmeriSouth. And even if they did belong to AmeriSouth, he argues that

AmeriSouth does not bear the loss-of its predecessor's investment because the City

takes care of repairs and replacement.'°

1.

Utility-Lines Ownership

We do find that Mesquite holds an easement for "constructing, operating and

maintaining a sanitary sewer main" across AmeriSouth's property and that the

utility lines are physically within this easement. Though the evidence the parties

have produced suggests that public utilities have the right to c*ons

ct and maintain

water mains and gas and electric lines, it does not show if that is

hat actually

happened. The Commissioner doesn't provide, nor do we find, any indication that

under Texas law an easement holder owns all property found within that easement.

Therefore, we cannot find that the mere location of the utility line within the

easement proves that AmeriSouth doesn't own them.

1° While such a result seems harsh, this nondepreciable intefest--similar to

one in land--will create a tax benefit upon disposition, at which point its tax basis

offsets the amount realized. See Wilshire-La Cienega Gardens Co. v. Riddell, 148

F. Supp. 938, 941 (S.D. Cal. 1956).

- 18 We do believe, however, that.the Commissioner has met his burden with

respect to th sanitary-sewer system. For this he demonstrates that Mesquite

obtained an easement before the apartments were erected for the specific purpose

of installing,)operating, and maintaining a sewer system. We find this to be more

probative than the simple fact that there was a general utility easement on

AmeriSouth s property. While AmeriSouth could rebut that evidence by showing

that it owned the sewer main it has not done so; and we thus deem this issue

conceded.

.

Finally, we have to answer the question of whether AmeriSouth owns the

overhead electric lines. The Commissioner notes that a survey of AmeriSouth's

property states that the overhead electric lines "encroach" on the property, and he

deduces the oÿerhead lines must not belong to AmeriSouth because one's own

property wou}dn't encroach upon itself. This would put a heavy load on a single

word, but he also more persuasively points out that AmeriSouth admits that it does

not own the transformers that handle the electric load in the lines. These

transformers áre smack in the middle of those lines. On this somewhat undertried

issue, that will have to do: We find it more likely than not that if Mesquite owns

the transformÊrs, it also owns the lines entering and exiting the transformers.

-192.

Responsibility to Repair

Though the Commissioner doesn't satisfy his burden as to tl e ownership of

the water-distribution system, the gas line, and the underground portion of site

electric, he alternatively claims that, even if AmeriSouth technically owns the

property, it can't take a depreciation deduction because it doesn't pay for repairs.

He notes that utility companies have.used the access easements for repair work.

We agree with Commissioner that-from the property line to the gas, water,

and electric meters, the city or utility companies are responsible f r the repair of

utility lines--AmeriSouth's manager admitted as much. But since AmeriSouth's

responsibility for repair begins once the utility line reaches the ga ket/meter on its

side of the meter, we must still decide whether the lines between the meters and the

buildings are structural components. See infra pp. 37-43.

B. .

Site Preparation and Earthwork

MS's cost-segregation study allocates $65,381 of Garden I ouse's

depreciable basis to "site preparation and earthwork," depreciabl over 15 years as

a land improvement. The study later refers to the same expenses às "site

development," but nowhere describes what work is included in this category.

AmeriSouth has submitted an exhibit that claims these expenses relate to "land

improvements for excavating, grading, stone bases and compaction needed to

- 20 construct sidewalks, parking and driveways," but the Commissioner's expert

claims that MS's workpapers show the expenses relate to the initial clearing and

grubbing (i.e!, tree removal) of the land before the apartments' construction in

1970. The Còmmissioner also says that AmeriSouth hasn't proven that the claimed

improvemenfs to land ever actually happened--for example, the Commissioner

notes the land could have been treeless in the first place. And the Commissioner

argues that e 570en

if the work did happen, clearing and grubbing isn't depreciable

because it's npt subject to wear and tear and generally makes the land more

valuable.

This máy overstate the matter a bit. While land generally isn't depreciable,

sec. 1.167(a)-2, Income Tax Regs., improvements to land or physical preparations

for land development may be depreciable if they are "closely associated with a

depreciable asset" Langer v. Commissioner, T.C. Memo. 2008-255, aff'd, 378 Fed.

Appx. 598. (8 h Cir. 2010); see also Rev. Rul. 65-265, 1965-2 C.B. 52, clarified by

Rev. Rul. 68- 93, 1968-1 C.B. 79 (costs for earthwork in preparation for buildings

or paving roadways are depreciable). If site preparation is "inextricably

associated" with the land itself, hówever, it is not depreciable. Algernon Blair, Inc.

v. Commissio er, 29 T.C. 1205, 1221 (1958). Thus the depreciability of site

- 21 improvements hinges on whether they relate to a depreciable asset or just to the

land itself.

This is a question of fact. And on this question of fact we find for theCommissioner. His determination has a presumption of correctne s and

AmeriSouth has the burden to overcome that presumption." See I ule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933). AmeriSouth also failed to address

this issue at trial and failed todile a posttrial brief. The only place AmeriSouth

refutes the Commissioner's determination is in an expert report abbut MS's cost-

segregation study, which cites the deposition of Philip Mann, the head of MS. The

report limits itself to a description of the assets and legal conclusions.° The

Commissioner's expert relied on MS's workpapers to.prepare his wn report. MS

created these workpapers contemporaneously with its study, and we find the

Commissioner's expert more reliable for relying on them. We note that

AmeriSouth failed to put these workpapers into evidence to undermine the

" In its petition, AmeriSouth suggests that the burden of proof shifts to the

Commissioner. See sec. 7491(a). But under section 7491(a), AmeriSouth has to

put forth credible evidence before the burden can shift, and it failed to do so at

trial.

" The expert, Eric Ernst of Ernst Consulting Group, Inc., s tes that the "site

development" included "clearing, grading and over seeding," but AmeriSouth

does not provide supporting facts. Ernst cites the deposition of Philip Mann, the

head of MS, but that deposition was never admitted into evidence.

- 22 Commissior er's characterization of what they held. We therefore sustain the

Commissioi r's determination that the costs related to initial clearing and grubbing

of the land are nondepreciable.

It's certainly plausible that some of the pre-1970 site preparation relates to

sidewalks, párking, and driveways and may therefore be depreciable, but

AmeriSouth has presented no evidence on this point. In this context--or lack of

context--we cannot uphold AmeriSouth's allocation between the costs of land and

site preparation. See Aurora Vill. Shopping Ctr., Inc. v. Commissioner, T.C.

Memo. 1970 39. We therefore sustain the Commissioner's determination that the

claimed "site preparation and earthwork" is nondepreciable.

II.

Classifying Property

li

AmeriSouth and the Commissioner don't dispute which recovery period

applies to each property class, but instead disagree upon the appropriate

classification of various items. The Commissioner claims all of the property in

question is part of the apartment buildings and therefore should be classified as

residential re 1 property. AmeriSouth argues that many components should be

classified as tangible personal property. In analyzing the situation, we find

ourselves facing a llano estacado with only such ambiguous landmarks as tangled

- 23 statutory cross-references (some to repealed sections of the Code) definitions by

both example and negation, and extremely fact-specific caselaw to guide us.

A.

Traversing the Code

We set off with the Code. Section 168(e) defines when a building is

residential rental property but does not define with precision wha a "building" is.

So we look instead for guidance on what "tangible personal prop rty" means.

First, section 168(e) tells us to classify property on the basis of its class life,

and section 168(i)(1) sends us to séction 167(m), as in effect befo e its repeal, to

determine what that is:" Former section 167(m) gave the Secretary authority to

provide guidance on the class lives for each class of property so taxpayers can

compute their depreciation expenses. Every so often the Secretar amends the

asset classes and periods that determine class lives and publishes the new ones in a

revenue procedure. See sec. 1.167(a)-11(b)(4)(ii), Income Tax. Regs.

The revenue procedure in effect for the years at issue is Re . Proc. 87-56,

1987-2 C.B. 674. The stated purpose of Rev. Proc. 87-56 is "to set forth the class

° Congress repealed section 167(m) in 1990, see Omnibus Budget

Reconciliation Act of 1990 (OBRA), Pub. L. No. 101-508, sec. 11812(a)(1), 104

Stat. at 1388-534, but section 168(i)(1) still incorporates that sec 040ion's

pre-repeal

language and treats the taxpayer as if it elected to have that sectión apply. Before

the repeal, section 167(m) essentially codified the Asset Depreciátion Range

system found in section 1.167(a)-11, Income Tax Regs.

- 24 lives of prop rty that are necessary to compute the depreciation allowances

available under section 168 of the Internal Revenue Code."" See Rev. Proc. 87-56,

sec. 1, 1987-2 C.B. at 674. To accomplish this purpose, Rev. Proc. 87-56, sec. 5,

1987-2 C.B. t 675, describes certain classes of property and their recovery periods

and lists othe asset classes along with their class lives and appropriate recovery

periods in a t elve-page table. If an item doesn't fall within that section or the

table (or is not otherwise provided for by statute), then the property is treated as

having no cla s life. Id. sec. 2.04, 1987-2 C.B. at 675. Rev. Proc. 87-56, sec. 5.02

reiterates that residential rental property has a recovery period of 27.5 years.

AmeriSouth relies on two classifications within Rev. Proc. 87-56 for its

claimed tangible personal property; asset class 00.3 (land improvements,

depreciable oier 15 years) and asset class 57.0 (distributive trades and services,

depreciable over 5 years)." It includes its water-distribution system, sanitary-

" Rev. Proc. 87-56, 1987-2 C.B. 674, incorporates and updates many items

from Rev. Proò. 83-35, 1983-1 C.B. 745, and replaces that revenue procedure for

property subjeht to section 168. See Rev. Proc. 87-56, secs. 5.03, 6, 1987-2 C.B.

at 675-76.

" The ùse of asset class 57.0 presents a paradox. Its description--"assets

used in wholesale and retail trade, and personal and professional services"--does

not seem to de¼cribe the property at issue. But in applying the definition of "5- year property" from a former version of section 168, see sec. 168(c)(2)(B) (as in

effect before the Tax Reform Act of 1986 (TRA 1986), Pub. L. No. 99-514, 100

(continued...)

- 25 sewer system, gas lines, and site electric in the former category, placing everything

else in the latter. But asset class 00.3 excludes "buildings and stru tural

components as defined in section 1.48-1(e) of the regulations." Id ,1987-2 C.B. at

677.i6

r

"(...continued)

Stat. 2085), we have held that a microwave and range used for ren al property are

5-year property, Subt v. Commissioner, T.C. Memo. 1991-429. That superseded

language of former section 168(c)(2)(B) survives in section 1.168 3(c)(2),

Proposed Income Tax Regs., 49 Fed. Reg. 5957 (Feb. 16, 1984), and the IRS has

clarified that certain personal. property used in a rental-real-estate etivity does fall

under asset class 57.0. See I.R.S. Announcement 99-82, 1999-2 C.B. 244, 244-45

(Aug. 9, 1999) (updating Form 4562). With this background in mind, and because

AmeriSouth and the Commissioner stipulate that asset class 57.0 describes

AmeriSouth's business, we won't further poke around at the proper classification

of AmeriSouth's tangible personal property if it turns out not to be residential real

property.

Rev. Proc. 87-56 is filled with references to section 1245 property and

section 1250 property. Section 1245 property includes personal p operty that is or

was subject to section 167 depreciation. Sec. 1245(a)(3). Sectior 1250 property

includes any real property that is or was subject to section 167 depreciation and

that is not section 1245 property. Sec. 1250(c).

- 26 A look at sections 1245 and 1250," with their accompanying regulations,

confirms tha section 1.48-1, Income Tax Regs., is our proper destination.

Depreciable personal property is section 1245 property. See sec. 1245(a)(3)(A).

Section 1245 in turn looks to section 1.48-1(c), Income Tax Regs., see sec. 1.12453(b)(1), Income Tax Regs., to define tangible personal property: "Tangible

personal property includes all property (other than structural components) which is

contained in or attached to a building", sec. 1.48-1(c), Income Tax Regs.

(emphasis added). Structural components are section 1250 property. See sec.

1.1250-1(e)(3)(i), Income Tax Regs.; sec. 1.1245-3(c), Income Tax Regs." And

" We can in general ask whether the property in question is section 1245

property or section 1250 property. Under ACRS, section 168 assigns a

classification and corresponding recovery period to property based on whether it is

"section 1245 class property" or "section 1250 class property." See sec. 168(c) (as

in effect befo e TRA 1986). Section 168 under MACRS no longer uses that

language and instead assigns property to recovery periods based on class lives, see

sec. 168(c), (e), but the distinction between the two types of property continues to

be relevant uilder MACRS, see Hosp. Corp. of America v. Commissioner, 109

T.C. 21, 54-55 (1997).

I

" Section 1.1245-3(c), Income Tax Regs., refers tó a category of section

1245 property, coined "other property," which is distinct from "personal property."

Nonetheless, for the purpose of defining structural components, section 1.12501(e), Income Tax Regs., detours us through that subsection to arrive at the relevant

definition.

--27 section 1.48-1(e), Income Tax Regs., provides the relevant definition of structural

components.

But upon finally arriving.at section 1.48-1, Income Tax Regs., our journey

takes a bit of a detour--we have an extant regulation derived from an extinct

statutory framework. The regulation is entitled "Definition of section 38 property,"

referring toformer section 38," which dealt with the investment tax credit (ITC).20

As a result, we also look to caselaw interpreting the ITC to deternhine whether

section 1.48-1(e), Income Tax Regs., classifies AmeriSouth's property as structural

components for purposes of depreciation. Hosp. Corp. of Am.'v. Commissioner,

109 T.C. 21, 54-55 (1997).

19 There is an explanation to the apparent numerical incongruence: Before a

1990 amendment, section 48 defined "section 38 property." See sec. 48 (as in

effect before OBRA).

20 Before its repeal, the ITC allowed taxpayers to recoup a portion of

expenses invested in their business, rewarding the taxpayer for cdpital

expenditures on equipment and machinery-seen as a boost to prdduction and thus

economic growth--but not for the outlays on the buildings that housed the

equipment and machinery. See, e.g., Scott Paper Co. v. Commissioner, 74 T.C.

137, 167-68 (1980).

- 28 B.

The Caselaw

Section 1.48-1(e), Income Tax Regs., defines "building" and "structural

components." The Commissioner and AmeriSouth agree that the apartments are

buildings but disagree about what a structural component is. Section 1.48-1(e)(2),

Income Tax Regs., says:

The te "structural components" includes such parts of a building as

walls, partitions, floors, and ceilings, as well as any permanent

coverinNs therefor such as paneling or tiling; windows and doors; all

components (whether in, on, or adjacent to the building) of a central

air congitioning or heating system, including motors, compressors,

pipes and ducts; plumbing and plumbing fixtures, such as sinks and

bathtub¼; electric wiring and lighting fixtures; chimneys; stairs,

escalators, and elevators, including all components thereof; sprinkler

systems; fire escapes; and other components relating to the operation

or main enance ofa building. [Emphasis added.]

Thus wé ultimately look to see if an item--whether inside or outside the

building--relates to the operation or maintenance ofa building to determine if it's a

structural component." See Scott Paper Co. v. Commissioner, 74 T.C. 137, 183

There is an exception. An item that would otherwise be a structural

component wi 1 be considered tangible personal property under section 1.48-1,

Income Tax Règs., if the sole justification for its installation is ''to meet

temperature or umidity requirements which are essential for the operation of

other machinery or the processing of materials or foodstuffs." Sec. 1.48-1(e)(2),

Income Tax R gs. Neither party argues that this applies to any property in this

case.

-29n.12 (1980). The catchall language in the final phrase modifies the specifically

listed items so that even they, in "unusual circumstances," are tangible personal

property when not relating to the overall:operation or maintenancé of a building.

Id. at 183.

The cases that have slogged through this operation-or-maintenance-of-a-

building morass have left a mess of hoof marks that sometimes makes it hard for us

to follow the right trail. And while always acknowledging the caselaw's emphasis

on the unique circumstances of each case, we navigate by relying on three

prominent landmarks--whether an asset is: (1) accessory to a business, (2)

permanent, or (3) "ornameritation".

1.

Accessory to a Business

One tool in our saddle bag comes from the Senate report accompanying the

ITC: "It is intended that assets accessory to a business such as g ocery store

counters, printing presses, individual air-conditioning units, etc., even though

fixtures under local law, are to qualify for the [investment tax] crëdit." S. Rept.

No. 87-1881 (1962), 1962-3 C.B. 707, 722 (emphasis added). One context in

which courts have largely applied an accessory-to-a-business analysis is when

property arguably serves a function specific to a taxpayer's business. See Hosp.

.-30Corp., 109 T C. at 69 (describing certain five-year property); Morrison, Inc. v.

Commissioner, T.C. Memo. 1986-129, aff'd, 891 F.2d 857 (11th Cir. 1990).

Handrails are thus accessory to a hospital's healthcare-service business when

placed in a corridor to aid patients, see Hosp. Corp., 109 T.C. at 83, and outside

lights are accessory to a psychiatric facility's business when installed to prevent

unwanted de artures by patients and to reassure residents in the area about security,

see Metro Nat'l Corp. v. Commissioner, T.C. Memo. 1987-38.

Property used directly with specific pieces of equipment may also be

accessory to á business22--because an item that specifically serves a piece of

equipment is not generally serving the building in which that equipment is placed."

See, e.g., Hosh. Corp., 109 T.C. at 79 (citing examples of property that "was

necessary to apd used directly with specific pieces of equipment and consequently

did not relate to general building" operations). This analysis came from Scott

22 We classified water piping that was set in the concrete beneath a cafeteria

kitchen, for eÈample, as tangible personal property--even though the piping could

be adapted for use by other businesses--because it actually served the taxpayer's

kitchen equiprhent and machinery. Morrison, Inc. v. Commissioner, T.C. Memo.

1986-129, aff'd, 891 F.2d 857 (11th Cir. 1990).

BecaÈse the property relates to equipment which in turn relates to the

taxpayer's business, the property is deemed accessory to a business. See Hosp. ;

Corp., 109 T.C. at 80.

- 31 Paper Co. v. Commissioner, 74 T.C. 137 (1980), where we had to decide whether a

manufacturer's primary-electric improvements qualified for the investment tax

credit. In Scott, we looked to the ultimate use of power, and held that "power used

to meet the demand of process machinery is not used in the overall operation or

maintenance of a building." See id. at 184.24

We have extended the reasoning of Scott to draint gas, and water lines which

serve a restaurant owner's equipment, see Diiaine v. Commissioner, T.C. Memo.

1985-39; to water piping that is connected to kitchen machinery nd equipment in a

cafeteria, see Morrison, T.C. Memo. 1986-129 (''[w]e conclude t at the kitchen

water piping is necessary to and is used directly with specific pieces of * * *

equipment"); and to electrical wiring, outlet receptacles, and other property which

power television sets in a hospital, see Hosp. Corp., 109 T.C. at 31, 68, 71. If, in

contrast, a component is connected not with specific equipment ut with a

structural component of a building, we are likely to classify it as part of that

building. See Metro, T.C. Memo2 1987-38 (toilet partitions had clear relation to

24 If the item serves both the taxpayer's equipment and the building

generally, e.g., electric wiring, taxpayers may accelerate depreciation of an item to

the extent equipment usage makes up total usage. See, e.g., Hosp. Corp., 109 T.C.

at 63-64.

-32plumbing facilities); see also Hosp. Corp., 109 T.C. at 68 ("disputed property item

constitutes a structural component to the extent that it furnishes electrical power for

a function or equipment that relates to the operation or maintenance of a

building"); Sámis v. Commissioner, 76 T.C. 609, 618 (1981).

2.

Permanence

We also have to evaluate the permanence of the component. Although

permanence id not always an overriding factor, see Hosp. Corp., 109 T.C. at 68

("that some of the wiring and conduit is contained in the walls and floors of the

hospitals is not relevant in determining whether those items are personal

property"); Mårrison, T.C. Memo. 1986-129 (kitchen water piping--tangible

personal property--was set in concrete), we have considered it in the accessory-toa-business cor text. See Metro, T.C. Memo. 1987-38 (finding that cabinets used

for tenants' business needs, which could be easily moved, qualified as tangible

personal~property). Of course, permanence is also a key factor for items that do not

serve a functiön unique to a taxpayer's business--such as carpet and wall and floor

coverings. See Hosp. Corp. 109 T.C. at 73-78; see also S. Rept. No. 95-1263, at

117 (1978), 1978-3 C.B. (Vol. 1) 321, 415.

- 33 But nothing human lasts forever, moving us to ask how permanent must a

component be to have "permanence?" Our cynosure is Whiteco Indus., Inc. v.

Commissioner, 65 T.C. 664 (1975).. In Whiteco, we considered six factors:

042 whether the property is capable of being moved and hether it had in

fact been moved;

042 whether the property is designed or constructed to rdmain permanently

in place;

.

.

042 whether there are circumstances which tend to show that the property

may or will have to be moved;

042 whether removal of the property would be a substantial and timeconsuming job;

. : ;

042 the damage the property would sustain upon removal; and

042. the manner of "affixation" of the property to the land.

Id. at 672-73.

Cases after Whiteco have finessed its basic structure. The ease and

frequency of moving the item in question helps determine its permanence, see, e.g.,

Hosp. Corp., 109 T.C. at 57, 74, but movability is not a controlling factor. Metro,

T.C. Memo. 1987-38 (noting that some of the examples of structural components in

the regulation are readily removable). Other indicia include the function and

design of the component, the intent of the taxpayer in installing tlie component, the

- 34 effect of the component's removal on the building, and the extent the component

can be reused after removal. Consol. Freightways, Inc. v. Commissioner, 708 F.2d

1385, 1390 (9th Cir. 1983) (citing Whiteco, 65 T.C. at 672-73), aff'g in part, rev'g

in part 74 T.C. 768 (1980); Mallinckrodt, Inc. v. Commissioner, T.C. Memo. 1984532, aff'd, 778 F.2d 402 (8th Cir. 1985).

3

Ornamentation

Becaus AmeriSouth also argues that several items serve as decoration, we

note an additiönal consideration listed in S. Rept. No. 95-1263, at 117 (1978),

1978-3 C.B. (Vol. 1) at 415: "[T]angible personal property * * * includes special

lighting * * *, false balconies and other exterior ornamentation that have no more

than an incide tal relationship to the operation or maintenance of a building."

Thus lights serving to accentuate the shrubbery outside of a building qualify as

tangible personal property, falling "squarely within the language of S. Rept. 95-

1263." Metro, T.C. Memo. 1987-38; see also Morrison, T.C. Memo. 1986-129

(deciding, after considering various factors, that the taxpayer's lattice millwork

served as deco ative ornamentation and thus was tangible personal property).

And the e remains one more tangle of brush that we still need to clear. A

major part of the parties' disagreement is about the appropriate benchmark for

- 35 Garden House--do we compare it to an apartment building or a mqre generic

building?. In other words, should the Court look to see if the items in question

relate to the structure, maintenance, or operation of a typical apartment building, or

to the structure, maintenance, or operation of a generic shell buildi g?

C.

Defining AmeriSouth's Building

AmeriSouth argues that Garden House should be compared o a "shell"

building when we decide what is necessary foi its operation and maintenance (or in

other words, when we determine what is a structural component). In AmeriSouth's

view, the only items that are structural components are those that are necessary to

provide general lighting, heating, cooling, and electricity to a nondescript building.

The Commissioner on the other hand argues that the rule is more pecific. He says

Garden House should be compared to á typical apartment building, and therefore

anything that is typical of an apartment building should be a structural component.

Like all the other factors that the parties point at to guide our way, the

definition of a building has been a factor, but not necessarily a deciding factor, in

other cases. -See, e.g., Morrison, T.C. Memo. 1986-129 (finding restroom

"accessories serve[d] no function particularly unique to a cafeteria"). 1 erhaps what

makes it so inviting for the parties to put this issue under the microscope in this

- 36 case is the context: residential real property, which rarely would have qualified for

the old ITC. In contrast to commercial buildings, which can house many different

types of businesses, residential real property contains but one: Providing lodging

and accessories to tenants. If "typicality" governs, one would be hard pressed to

find any "unique" components in a rental apartment building.

We nefertheless think that AmeriSouth is wrong to argue that we should use

a barebones building as our base line." Section 1.48-1(e)(2), Income Tax Regs.,

explicitly lists items that are not common to all buildings--e.g., stairs, escalators,

elevators, and bathtubs. We read this as the regulation's telling us to take into

account the type of building that the components are part of.26 See, e.g., Metro,

T.C. Memo. 1987-38 ("[W]e are looking at the structure of the building,

ascertaining the components relating to the operation and maintenance of a

building as rental space." (Emphasis added.)).

We n te that several of Rev. Proc. 87-56's predecessors used the word

"shell" to describe a building, see Rev. Proc. 72-10, 1972-1 C.B. 721, 730; Rev.

Proc. 62-21, 1962-2 C.B. 418, 419, but even assuming that modifier sheds light on

the area, it still begs the question whether we look at the shell of a generic

building or thÉ shell of an apartment building.

26 In def ning "building", the regulation also notes various building

purposes. Se . 1.48-1(e)(1), Income Tax Regs.

-37So we will start by asking whether a component relates to the operation or

maintenance of an apartment building, but we can't stop there. -Tliough

AmeriSouth would find it difficult to argue that any of the contested components is

unique to its business, AmeriSouth might be able to show that sonie components

are not permanent, see, e.g., Hosp. Corp., 109 T.C. at 88 (seeing nothing unique

about bathroom accessories but still applying a permanency analysis to determine

whether they are structural components), or that they serve specific items of

equipment rather than the building generally, see Morrison, 891 F.2d at 863

("Components of primary electrical systems that supply electricity to the overall

operation or maintenance of a cafeteria building do not qualify for the investment

tax credit," but components "that distribute electricity to non-structural components

of [the taxpayer's] business [do].").

We now have at least a rough map to guide us in exploring AmeriSouth's

depreciation claims, which we look at in the same order the parties used.

IV.

Depreciable Lives

A.

Water-Distribution System

The Commissioner and AmeriSouth calculate the water-di tribution-system's

depreciation differently:

042

- 38 Year

Per IRS

Per AmeriSouth

2003

$3,556

$6,176

2004

4,491

11,734

2005

4,491

10,560

Total

12,538

28,470

AmeriS uth's water-distribution system includes the water and fire lines, fire

hydrants, and 'trenching and backfill." AmeriSouth describes trenching and

backfill as (1) excavating soil where the utility will lay water lines, (2) testing the

soil and ensuring it's suitable, (3) laying the lines, and then (4) replacing the

excavated soilP It argues that the lines running from the municipal water main to

the buildings re tangible personal property with a recovery period of 15 years.28

The Commissibner argues that, to the extent AmeriSouth owns the water-

"Trenähing and backfill" also affects depreciation of the sanitary-sewer

system, the gas line, and site electric because builders install those components in

ways very similar to the way they install a water-distribution system.

28 Only d portion of the lines is still at issue. The water-distribution system,

along with the anitary-sewer system and gas-line categories, includes lines that

run from an off-site source to meters on the property, and then from the meters to

the building. Because we have already decided AmeriSouth does not own the

lines until they reach the meters, it can depreciate the lines only to the extent they

run from the m¼ters to the buildings. How fast it can depreciate these lines is the

issue we decidë.

- 39 distribution system, it's a structural component of the buildmgs and therefore

depreciable only over 27.5 years.

-

--

It is clear to us that.the water-distribution system is an inte ral part of the

buildings's plumbing and air:conditioning systems and also serv s the building

generally by providiná potable water. See Samis, 76 T.C. at 618. Thus

AmeriSouth's argument that the water-distribution system could service the land

appears to hinge solely on.the fact that it is outside the building. But that fact does

not affect our finding that the components relate to the operation and maintenance

of the apartments. See Scott, 74 T.C. at 183 n.12 ("Property can kelate to the

overall operation and maintenance of a l uilding, even though it is not located

within the building"). Accordingly, AnieriSouth must depreciate the waterdistribution system's components over the life of the apartment buildings.

B.

Sanitary-Sewer System

Year

Depreciation per

IRS

Depreciation per

AnderiSouth

2003

$2,699

$4,688

2004

3,409

8,906

2005

3,409

8,016

Total

9,517

21,610

- 40 The sanitary-sewer system includes sewer lines extending from the buildings

to the munici al sewer, sewer manholes, and the trenching and backfill for those

lines. We have already found that AmeriSouth can't depreciate the sanitary-sewer

system, but w also find that AmeriSouth fails to distinguish these components

from those of the water-distribution system. AmeriSouth's trial witness states a

general purpose for the system--"[a]ll your drains, everything inside the building

goes in the sanitary system." Because the system serves the building generally,

even if it were owned by AmeriSouth, it would be part of the buildings.

C.

Gas Line

Year

Depreciation per

IRS

Depreciation per

AmeriSouth

2003

$1,356

$2,354

2004

1,712

4,473

2005

1,712

4,026

otal

4,780

10,853

The gas ines are similar. Under the "gas line" category, AmeriSouth

includes both gas lines that extend from the utility source to the buildings and the

cost of trenching and backfill. These gas lines do not materially differ from the

other utilities.

'he only additional argument we glean from the record is that if the

- 41 building had commercial use, it might not need the gas line. But ap we have

previously found, the correct analysis is whether the gas line relat s to the

operation or maintenance of an apartment building. Accordingly, khe items under

this category are structural components of the building, and AmeriSouth must

recover the costs over the life of the apartment buildings.

D.

Site Electric

Year

Depreciation per

IRS

Depreciation per

AmeliSouth

2003

$5,478

$9,514

2004

6,918

18,076

2005

6,918

1 ,268

Total

19,314

43,858

The site electric involves lines--both underground lines (pri ary and

secondary conduit and wire) and overhead electric service--as well as trenching and

backfill. AmeriSouth also includes wall packs (exterior lighting) in this category.

Because AmeriSouth puts forward the same arguments for the underground

lines, which include the trenching and backfill, as it has for the utilities we have

already discussed, the underground lines meet the same fate--we find that they are

structural components of the buildings. And since we have resol ed the ownership

- 42 of the overhëad electric service issue in favor of the Commissioner, we concentrate

our efforts on the wall packs.

The w 11 packs illuminate the exterior of the apartments for the convenience

and safety of the tenants. Beyond this general purpose, AmeriSouth provides no

other evidence that the wall packs are specialized lighting, see Metro, T.C. Memo.

1987-38, or are otherwise not structural components of the building. We find for

the Commissioner.

E.

Special HVAC

Year

Depreciation per

IRS

Depreciation per

AmeriSouth

2003

$548

$3,809

2004

692

6,094

2005

692

3,656

Total

1,932

13,559

The vepting connected to the stove hoods and the venting connected to

clothes dryers in the apartments make up Special HVAC.29 AmeriSouth has units

with washer gnd dryer connections for tenant use and seven common laundry rooms

29 AmetiSouth referred to the stove hoods as "microwave hoods," but at trial

we learned thÅt the apartments had no microwave hoods.

- 43 with washers and dryers operated by Coinmach. The clothes-dryer vents are fourinch metal pipes that extend from the back of the clothes dryers to the outside of the

buildings. The venting that extends from the stove hoods pulls sm6ke, humidity,

and hot air out of the kitchens.

The clothes-dryer vents serve specific equipment--the dryers. .Sg Morrison,

T.C. Memo. 1986-129 (finding that kitchen water piping served e uipment and was

not general building plumbing). The vents expel hot air and carbon monoxide and

reduce humidity. These vents extend directly from the dryers to tl e outside of the

building and have no connection to the apartments' general ventilation system. The

Commissioner argues that the clothes-dryer venting serves the funption of

ventilating the apartments. But he has failed to show how the venting services the

apartments generally apart from the clothes dryers. Therefore, we find for

AmeriSouth.3°

3° AmeriSouth has few electric dryers (though tenants can rent them) and

does not own any gas dryers--Coinmach does. The Commissioner did not concern

himself on brief with ownership of the dryers (ownership of clothés washers and

dryers came up only with allocating "rough-in" costs), but we do. While

nonownership, and lack of use, may be evidence that components are used only for

general building operation, in this case it's a distinction without a difference. See

Samis v. Commissioner, 76 T.C. 609, 620 n.6 (1981) (ownership $ras irrelevant in

light of congressional intent). We find that the vents are designed for the use of

(continued...)

We arê, however, not convinced that the vent hoods above AmeriSouth's

stoves are tangible personal property. Although they serve equipment-AmeriSouth s kitchen ovens--we are not convinced that they serve only the stoves.

AmeriSouth bontends that the vents remove both heat and smells. The

Commissionér counters that these odors and heat can come from beyond the

stovetop, and, we agree. AmeriSouth does little to rebut the Commissioner's

argument, an so we find that the hoods are structural components of the buildings

and must be depreciated over 27.5 years. See Morrison, T.C. Memo. 1986-129

("[W]ithout donsideration of the 'sole justification' test the kitchen air makeup unit

would constihite a structural component").

F.

.

Special Plumbing

_Ye_ar

Depreciation per

IRS

2003

$6,976

2004

8,810

77,539

2005

8,810

46,524

Total

24,596

172,525

3°(...continued)

the dryers and serve no other purpose.

Depreciation per

AmeriSouth

.

$48,462

-45AmeriSouth also claims accelerated depreciation for what it terms "special

plumbing." Special plumbing consists of sinks, garbage disposal5, waste-andrough-water piping connected to dishwashers and clothes washers, floor drains as

well as the waste lines running from the floor drains, and laundry room gas lines.

1.

Sinks

We first look into AmeriSouth's sinks--the kitchen sinks and the plastic

utility sink in the office building.F AmeriSouth concentrates most of its persuasive

efforts on the permanence of the sinks. ·AmeriSouth,argues that the sinks are easy to

remove--disconnect the sink from the water lines and remove approximately four

screws or clamps--and uses the 2003 apartment renovations as an example.

But section 1.48-1(e)(2), Income Tax Regs., specifically lists sinks as

structural components ("'structural components' includes * * * plumbing fixtures,

such as sinks and bathtubs"). And while AmeriSouth tags this ty e of plumbing

with the epithet "special", providing water for the kitchen is hardly unusual in the

" AmeriSouth factors in the location of an apartment sink to determine

depreciable life. AmeriSouth's expert states that "bathroom[ ] [s nks] are

considered by the IRS as being a part of a normal function of a building, and

kitchen sinks typically are not considered a normal function of a building."

Apparently from AmeriSouth's perspective, "this comes back to experience of

working with the IRS. You can't be so greedy that you take evefything."

- 46 sense of Scott and later cases, and AmeriSouth fails to give any other evidence that

it periodically replaced or even planned to replace sinks after the 2003 renovation.

So we find the sinks are also structural components of the buildings and not

depreciable apart from them.32

2.

Piping

As for the garbage disposals, AmeriSouth claimed depreciation for them as 5year property,yand the Commissioner did not adjust their depreciation. This leaves

waste-and-rough-water piping. In the kitchens, the waste piping connects to the

garbage dispo 541als

and carries away the water and wáste coming from kitchen sinks.

The rough-wat,er piping is fittings that connect the straight pipes coming from the

il

wall to the sinks. Because we have already decided that the sinks are structural

components, we also find drain pipes to be integral parts of the buildings' plumbing,

and thus are al o structural components. See Hosp. Corp., 109 T.C. at 68." "

" AmeriSouth also argues that sinks are not needed in a generic building,

contrasting its buildings with office buildings. We have already dispensed with

this argument by holding that we look at the operation and maintenance of an

apartment buil ling.

Apart from the general description in MS's cost-segregation study,

AmeriSouth does not provide a clear picture of any other piping that extends from

the dishwashe It made no argument peculiar to dishwasher piping at trial, nor

(continued...)

- 47 AmeriSouth also claims it has waste-and-rough-water piping for clothes

washers in individual apartments and the shared laundry rooms. The record does

not clarify whether this category deals only with components·visible from the

apartment side of the wall or whether pipes behind the wall (or'soine part of them)

are also included. The inspection and testimony of the Commissioner's expert

provide useful information. The term "rough" or "rough-in" refers to installing the

plumbing fittings (e.g., water and drain lines) that connect a specific component,

such as a sink or other plumbing fixture, to a building's plumbing lines.

AmeriSouth, however, provides no evidence that the piping in question runs from

where clothes washers are connected to the building's plumbing lines in the wall.

See Des Moines Cold Storage Co. v. Commissioner, T.C. Memo. 1988-241 n.6

("Since petitioner has the burden of proof, it must suffer the consequences of an

inadequate record"). We find for the Commissioner.

"(...continued)

did it file a posttrial brief. We find that it has thus conceded any additional issues

in this category. See, e.g., Lunsford v. Commissioner, 117 T.C. 183, 187 n.6

(2001).

- 48 3.

Laundry-Room Drain, Gas-Line, and Waste Lines

In AmeriSouth's seven shared laundry rooms, there are gas lines which run

from the primary gas lines to clothes dryers. There are also drains and waste lines

which run frÃm the drains to pipe water out. The parties agree that the purpose of

the drains is to prevent a flood from spreading throughout the building if a pipe

leading to th clothes washers breaks.

For AmeriSouth, this category is a wash. We do not agree with the

Commission r that the gas lines in question are part of the buildings' general

plumbing systems. These secondary lines do not supply gas to the building

generally; thëy supply it only to the dryers. See Duaine, T.C. Memo. 1985-39

("[G]as conn ctors from the building's main gas line service the restaurant's

cooking elements" and "do not relate to general building services").

But AmeriSouth does not persuade us that the drains, and waste lines

connected to he drains, are similar. Unlike the dedicated gas lines, they're a

permanent part of the building, and AmeriSouth does not argue otherwise. And

unlike some óf the components we look at, the drains do not appear to be necessary

for the effective operation of equipment. See Morrison, T.C. Memo. 1986-129

(finding that drains in the kitchen did not relate to the general drainage of waste

- 49 from the cafeteria building where they drained wastes resulting from food

preparation activities and serviced specific equipment). The stated purpose is to

protect the apartments, not the washers and dryers, so we find for the Commissioner

on these components.

G.

Special Electric

Year

Depreciation per

IRS

.

Depreciation per

AmeriSouth

2003

$6,689

$46,468

2004

8,448

4,349

2005

8,448

44,610

Total

23,585

165,427

AmeriSouth's most detailed category is special electric. It begins where site

electric ends--with the main panels connected to the outside lines -and comprises

some internal wiring and the assets that are connected to the internal wiring, such as

light switches, outlets, and paddle fans. AmeriSouth claimed accelerated

depreciation for components in both its apartments and its office:

- 50 Office

Paddle fans

Sign flood light

Recessed li hts

Spot lights

Closed circuit surveillance, camera,

and monitor

Sliding-gate components

Outlets

Apartments

Outlets

Door bells

Paddle fans

Dining chandeliers

Light switches

Wiring

Main and unit electric panels

Timers (irrigation and wallpacks)

Electric panel

Timers (irriÈation and wallpacks)

AmeriSouth's wish list is long, but its supporting evidence is limited. We can

extinguish its argument about recessed lights, referred to as "decorative", and spot

lights, which are presumably for security. AmeriSouth did not provide evidence of

how the light serve a decorative or security purpose, see Metro, T.C. Memo. 198738, so we find they are structural components. AmeriSouth also fails to show how

its door bells are anything but permanent components of the building. Finally, we

have already found the wallpacks to be structural components of the building, and

AmeriSouth does not show that their timers are other than integral to operation of

these structural components. That makes these assets structural components too.

The Commissioner concedes that the gate components are land

improvements, depreciable over 15 years, as are the duplex outlet and timer relating

- 51 to the watering of the grounds. The parties also agree that the s veillance

components--consisting of a camera and TV--as well as the sign flood light and

accompanying timer, are tangible personal property. That still leaves us with

several items to consider.

1.

Paddle Fans and Light Fixtures

Although the dining areas of the apartments are similar in layout, some have

the bonus of not only a paddle fan but an attached light fixture.34 Because the others

do not, the lighting provided by thesé combination light-fans arguably serves to

provide ambiance and only incidentally serves as general lighting. See Morrison,

T.C. Memo. 1986-129 (finding chandeliers were purely decorative and not a major

source of light). But AmeriSouth failed.to provide evidence on that point at trial."

Nor does it argue that the fans were primarily decorative. Although these

components can be moved during a remodeling, AmeriSouth does not provide

34 MS's cost-segregation study refers to the light fiktures a tached to paddle

fans as dining chandeliers.

" And the direct testimony of AmeriSouth's cost-segregation-study expert

that "[t]he light fixture itself is used for general illumination in tlÅat space" even

serves to undermine it.

- 52 evidence of actual or planned systematic replacement.36 See Shoney's S., Inc. v.

Commissione'r, T.C. Memo. 1984-413 (finding, along with other factors, that the

average five-to-seven-year replacement of chandeliers was evidence they were not

structural components). Simply arguing these assets are not part of the building

without pointi g out why is not enough. We find for the Commissioner.

2

Outlets

Althou h AmeriSouth refers to the outlets in this category as "specialized,"

there doesn't seem to be anything special about them. AmeriSouth argues that these

outlets are necessary to operate personal property; but that does nothing to

distinguish the "special" outlets from any other outlet in the apartments or office.

The fact alone that a copier, treadmill, toaster, or other item of personal property

happens to be þlugged into a specific outlet in no way indicates that the outlet is for

that specific use rather than the general operation or maintenance of the building.

See Hosp. Corþ., 109 T.C. at 70-71. We thus agree with the Commissioner that the

countertop outlets and the outlets that a treadmill, copier, and cycle might plug into

are structural omponents.

36 At tri 1, AmeriSouth elicited testimony that landlords typically replace

chandeliers wlienever they remodel a building. The testimony did not give

specifics for AmeriSouth's buildings or, for that matter, any other buildings.

- 53 On the other hand, we find that duplex outlets that are four- eet above the

ground in kitchen areas clearly accommodate refrigerators, which re personal

property. The layout of the kitchens and the location of these outlets leave little

doubt they are specifically for refrigerators. Sée Hosp. Corp., 109 T.C. at 31, 71

(outlet receptacles used for televisions in hospital rooms are persohal property).

The same is true with respect to the 220-volt outlets in kitchen are s that are used

solely for powering stoves and the outlets in laundry areas for washers and dryers.

Similarly, the cable, telephone, and data outlets are used for items that are not

structural components, so they are considered part of those items. See id. at 72

(phone jacks are used with telephone equipment and thus are considered personal

property).

The Commissioner doesn't refute our holding in Hospital Corp., nor does he

attempt to distinguish it. He instead argues that "electric wiring" is listed in the

regulation. He's right. And we also agree that AmeriSouth doesn t provide

evidence that these components are not permanent. But the regulation emphasizes

the relationship of a component to the operation or maintenance of.a building, and

in unusual circumstances--when that item relates to a specific piece of equipment--it

- 54 is not a struchiral component. See, e.g., Hosp. Corp., 109 T.C. at 64-72; Scott, 74

T.C. at 183. pn these components we find for AmeriSouth.

3.

Wiring

LI

The p rties stipulate that the wiring in question runs from a unit panel in each

apartment to þutlets near kitchen garbage disposals, dishwashers, and the hood over

the stove.38

meriSouth has the burden to produce evidence that this wiring

supplied po er for the specific personal property claimed, and the evidence we do

have is uncle : AmeriSouth's expert described the wiring as a hard or direct

connection t the personal property, but other evidence showed that the wiring in

question runs through the wall cavities to outlets these pieces of property plug into.

And if the lat er situation's the case, the Commissioner's expert stated it's possible

that the wiring connects to other outlets. Since AmeriSouth never showed that the

wiring suppliéd power for these specific components and not the apartments

" The Èommissioner does not present evidence of how these components,

clearly in use for specific property, could be adapted for general uses. We

therefore do not need to decide to what extent the reasoning of A.C. Monk & Co.

v. United Statès, 686 F.2d 1058 (4th Cir. 1982), might apply.

38 Ame South's expert described a microwave hood, but again, that's

blowing smol e--there are no microwave hoods in the apartments, only stove

hoods.

-55generally, we find for the Commissioner. See Des Moines Cold S orage, T.C.

Memo. 1988-241 (the taxpayer did not submit evidence other than self-serving

testimony that wiring supplied power for particular system rather than contributing

to the overall operation or maintenance of the property).

4.

Electric Panels

AmeriSouth claims that it should have a shorter recovery period for a part of

the main and unit electric panels in the buildings, because some p rcentage of

electricity flowing through those panels is used for personal property. In Scott, we

allowed an allocation, see Scott, 74 T.C. at 185-87, but later caselaw has been much

stingier, see A.C. Monk & Co. v. United States, 686 F.2d 1058, 1064-66 (4th Cir.

1982) (saying better approach is to determine whether an electrical system has more

general uses than simply operating specific pieces of machinery). We do not need

to decide whether allocation is appropriate in this öase because we find that

AmeriSouth has failed to reliably substantiate its allocation of the osts of the

electric load between specific equipment and the overall requirem nts of the

building. See Des Moines Cold Storage, T.C. Memo. 1988-241. The problem here

is that the electric panels have faulty or missing labels. And AmeriSouth, instead of

testing the units, just extrapolates from bad data on some of the units to come up

- 56 with an allocation for all the panels in all the buildings. We therefore find that it

must deprecihte the panels over the life of the apartments.

H.

Finish Carpentry

Year

Depreciation per

IRS

Depreciation per

AmeriSouth

2003

$5,992

$41,629

2004

7,568

66,606

2005

7,568

39,964

Total

21,128

148,199

Finish arpentry comprises the shelving in pantry closets and in the livingroom-wall re esses, the shelving in the office building, wood-base, crown molding,

chair rails, wood paneling, and closet rods.

.

AmeriSouth does not argue that these items are accessory to its business but

does argue th t the shelves and closet rods are readily removable without doing any

damage to the walls. It also argues that the molding and paneling enhance the

apartments' decor and are therefore not mere structural components.

The Commissioner does not dispute that these items are movable, but tells us

to focus on other signs of their permanence: The design of the buildings,

particularly tl e wall recesses in the living rooms, accommodates permanent

- 57 shelving; the shelves allow for storage, a necessity in an apartment building; and the

paneling, molding, and chair rails protect other parts of the buildings, such as the

floors, walls, and ceilings, from damáge.

We agree with the'Commissioner. Though the shelves and closet rods are

moveable, movability isinot the only sign an asset lacks permanence. See, e.g.,

Consol. Freightways, 708 F.2d at 1390. AmeriSouth fails to shoy that it actually

moved or planned to remove arid feuse the shelves or closet rods, see Hosp. Corp.,

109 T.C. at 88, and doesn't point to any other indication of nonp rmanence. We

therefore find that these items are also síructural components of t e buildings.

We also conclude that the päneling, molding, and chair rails are structural

components of the buildings. Paneling is specifically mentioned in the regulations.

See sec. 1.48-1(e)(2), Income Tax Regs..("the term 'structural components' includes

* * * permanent coverings * * * such as paneling"). And although these items are

also decorative, they are not items that "fall squarely" within the language of S.

Rept. No. 95-1263 explaining wliát constitutes tangible personal property. See

Metro, T.C. Memo. 1987-38 (security lights, grow lights, and decorative lighting are

"special lighting," which falls within language of report); Morrison, T.C. Memo.

1986-129 (lattice millwork fell within "removable partition" language of report).

-58I.

Millwork

Year

Depreciation per

IRS

Depreciation per

AmeriSouth

2003

$16,860

$117,121

21,293

187,393

2005

21,293

112,436

Total

59,446

416,950

2004

'

AmeriSouth's millwork consists of cabinets and countertops. Their proper

classification is strictly an issue of their permanence-AmeriSouth argues that they

are all removable. But, as with finish carpentry, AmeriSouth did not present any

evidence about the additional factors regarding their permanence that we need to

consider. We therefore make the same finding as we do on finish carpentry: The

millwork is a structural component.

J.

Interior Windows and Mirrors

ar

Depreciation per .

IRS

Depreciation per

AmeriSouth

2003

$1,389

$9,651

2004

1,755

15,442

005

1,755

9,265

Total

4,899

34,358

- 59 This penultimate category includes the office's interior windows, as well as

the mirrors found on the walls of all the apartments' dining rooms, and the mirrors

found in all the apartments' bathrooms. In his report, AmeriSouth's costsegregation expert states that an interior window "is not an asset we would normally

treat as 1245 property unless the wall itself was demountable or the window served

another unique function." But AmeriSouth presents no evidence of removable walls

or the uniqueness of the windows. We find the windows to be structural

components.

AmeriSouth's former attorneys also reflected little on the mirrors during trial.

They tried to get testimony of the mirrors' decorative function from an adverse

witness, but AmeriSouth's own witness stated the dining-room mirrors had "no

function." The mirrors are removable, but we see no other evidence that these

mirrors are not permanent. See Hosp. Corp., 109 T.C. at 88. We believe

AmeriSouth intends the mirrors to stay where they are, and so we find that the

mirrors are part of the building.

- 60 K.

Special Painting

Year

Depreciation per

IRS

Depreciation per

AmeriSouth

2003

$861

$5,983

2004

1,088

9,573

2005

1,088

5,744

Total

3,037

21,300

AmeriSouth considers the paint on shelves, wood base, chair rails, closet

rods, and crown molding as special: special because AmeriSouth considers the

assets that the paint covers to be section 1245 property. AmeriSouth's former

attorneys asked at trial whether the classification of the paint should follow that of

the items pai ted, and the Commissioner's witness responded yes. We see no

reason to coa that succinct view with any additional analysis-those items are

structural components and, therefore, so is the paint.

- 61 Conclusion

We have reached the end of the trail. Most of the Commissioner's arguments

have survived, but a few were lost along the way and therefore

Decisian will be entered

under Rule 155.